The Realities of Market Failure

Paul Krugman jumped further in to the health care reform debate today just as the CBO announced that the Obama Plan, billed as a cost-saver, continues to be anything but cost saving. Krugman rightly points out that in a land of third party payers, you are not going to find a free market solution. This is simply true by definition so why is there so much confusion?

Krugman borrows heavily from an earlier treatise by Kenneth Arrow, one of the early pioneers of modern economics in a 1963 treatise called Uncertainty and the Welfare economics of health Care. (Note: The link on Krugman’s blog is bad so use mine.) Let me just mention here that Welfare in economics means you’re looking for allocative efficiency within an economy given that economy’s income distribution. Since so few folks in this country have the majority of income and resources, for example, the U.S. is a considered about average on allocative efficiency. Our resources are not distributed based on the aggregate welfare of society. We have a system where there are winners and losers because most of our goods are distributed by ability to pay and most of that ability to pay comes from accident of birth.

So, Krugman updates the Arrow treatise and argues that healthcare is not what you would refer to as a standard market that would thrive under free market conditions. He points to two very distinct characteristics that takes it out of contention for a completely free market solution which borrow heavily from Arrow.

There are two strongly distinctive aspects of health care. One is that you don’t know when or whether you’ll need care — but if you do, the care can be extremely expensive. The big bucks are in triple coronary bypass surgery, not routine visits to the doctor’s office; and very, very few people can afford to pay major medical costs out of pocket.

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The second thing about health care is that it’s complicated, and you can’t rely on experience or comparison shopping. (”I hear they’ve got a real deal on stents over at St. Mary’s!”) That’s why doctors are supposed to follow an ethical code, why we expect more from them than from bakers or grocery store owners.

If you’ve followed any of my blogging carefully, you will recognize two underlying themes that we’ve frequently talked about throughout Krugman’s assessment. That would be that the health care market has the two nasty frictions of moral hazard and information asymmetry. Insurance companies, theoretically, should provide cost effective remedies to both. However, there are things unique to health insurance and the underlying risk of getting catastrophic illnesses that make huge risk pools the most cost effective. This is the primary economic argument for universal healthcare. Putting every one (the healthy and the unhealthy) into one HUGE risk pool, minimizes the cost to everyone, thereby maximizing allocative efficiency and economic welfare. Insurance companies that cherry pick, and healthy folks that self opt-out of risk pools, violate these principles and make it more expensive and less efficient for every one.

The other bottom line is the information asymmetry which Krugman describes. Who are you going to rely on for information on very complicated health decisions when you’re not an expert on illness, treatment, and costs? Right now, we’re relying on profit-making, third party agents called private health insurers. Some of these decisions are driven by supplier partnerships more than health care decisions. I pay more for one kind of drug because my insurer gets discounts from one drug company by disallowing competitive pricing of the drug that works best for me made by that company’s competitor. Is this any better than using a single payer, universal health care plan either ran by the government or farmed out to an quasi agency that would have monopoly bargaining power that benefits patients and not the supply chain? Here’s Krugman’s bottom line.

You could rely on a health maintenance organization to make the hard choices and do the cost management, and to some extent we do. But HMOs have been highly limited in their ability to achieve cost-effectiveness because people don’t trust them — they’re profit-making institutions, and your treatment is their cost.

If this current situation was working so well, we wouldn’t have the symptoms of market failure and we wouldn’t have so many studies and comparisons that show that the U.S. pays way too much and gets way too little compared to other systems. Now, this always begs anecdotal evidence from some one. In any study relying on a population you are going to get outliers and some one can undoubtedly find the outlier. The deal is, when you aggregate the numbers for the healthcare system in this country, it is expensive and inefficient. That is coupled with this huge information asymmetry problem exacerbated by misleading ads by advocacy groups. Political ads do not have to pass the same smell test that ones selling bottles of detergent so we get completely bad information.

The public demands for change continue because nearly every one realizes the current system is not working. But how do we justify patchwork changes that may or may not pick up healthcare insurance for some of the millions without? How can we continue our buy-in to an overpriced and inefficient delivery system? Again, we don’t need to change health care on the ground, our hospitals, doctors and nurses. These folks are not the problem. It’s the third party payers that get in between patients and their health care providers. They are creating more costs, less efficiency, and a lot of noise! They’ve provided the conditions for market failure so why perpetuate it?

So, here’s the CBO’s assessment of this current Obama plan. The Obama plan just creates a patchwork of inefficiencies when one central insurance entity is really the most allocative, quantity maximizing and cost efficient system. (One major argument for the existence of a monopoly is when there is absolute effiency of scale.)

For the second time this month, congressional budget analysts have dealt a blow to the Democrat’s health reform efforts, this time by saying a plan touted by the White House as crucial to paying for the bill would actually save almost no money over 10 years.

A key House chairman and moderate House Democrats on Tuesday agreed to a White House-backed proposal that would give an outside panel the power to make cuts to government-financed health care programs. White House budget director Peter Orszag declared the plan “probably the most important piece that can be added” to the House’s health care reform legislation.

But on Saturday, the Congressional Budget Office said the proposal to give an independent panel the power to keep Medicare spending in check would only save about $2 billion over 10 years- a drop in the bucket compared to the bill’s $1 trillion price tag.

“In CBO’s judgment, the probability is high that no savings would be realized … but there is also a chance that substantial savings might be realized. Looking beyond the 10-year budget window, CBO expects that this proposal would generate larger but still modest savings on the same probabilistic basis,” CBO Director Douglas Elmendorf wrote in a letter to House Majority Leader Steny Hoyer on Saturday.

This Politico story continues with the description of Orzag blowing off the concerns over the lack of cost savings along the vein of what’s been going on with the inefficient and costly stimulus plan. It’s like Hey, it doesn’t work like we promised, but at least we did something. The bottom line is that we really aren’t going to get massive cost savings by simply morphing the current system. This is a failed market with multiple third party payers, all seeking to make profits off of massive amounts of information asymmetry and creating multiple levels of moral hazard.

I have to say, that I completely hate the disingenuous arguments we’ve seen to date coming from nearly all sides of this problem given the importance of this issue. I’m tired of conservatives saying “I’ve got mine!’ It’s really short-sighted on so many levels as to be pathetic. The rich may be able to afford Cadillac plans but believe me, more and more of them will pay more and more in deductibles and premiums the further we allow this failed market to continue. I also hate this something is better than nothing argument because it will doom to failure what we could really achieve. If there was reliance on the data surrounding the various universal health care plans around the world instead of commercials based on anecdotal stories, it would be an easy sale.

The only thing that I can see in this is that policy makers are also stakeholders in perpetuating the current system of third party profiteering. It’s the only reasonable hypothesis. To borrow whole sale from Woman Voter: HR 676 Single Payer, Everyone In, Nobody Out…It’s All American!

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